By Tiernan Ray

Bernstein Research‘s Toni Sacconaghi today reiterated a Market Perform rating on shares of International Business Machines (IBM), and a $180 price target, writing that investors have cooled on the company’s constant earnings goals, and instead are starting to focus more on the company’s revenue growth, and as such, which could hold back the shares.

Sacconaghi points out that IBM has routinely beaten the multi-year earnings forecasts it has been offering the Street since 2006:

IBM first introduced its 2006-10 roadmap in 2007, calling for EPS to increase from $6.06 in FY06 to $10 in FY10 (and $11 factoring in expected pension savings at the time). IBM actually reached its $10 target in FY09, and eventually delivered $11.52 in GAAP EPS in FY10. While IBM’s revenue growth lagged its original target (2.2%/year vs. a target of 7-8% including growth initiatives and acquisitions), the company more than made up for the shortfall through margin expansion/cost reductions and share repurchases. Moreover, IBM announced a new roadmap in 2010 that called for EPS to increase to $20 by FY15 (~12% EPS CAGR), which the company comfortably delivered on 2011 and 2012. IBM’s ability to meet and eclipse its targets was well rewarded by the market, as the stock outperformed by 88% from the date when IBM introduced its first roadmap (May 17, 2007) through the end of 2012.

But with the Q4 report a week and a half ago, investors have started to shrug off the EPS upside, as earnings seem of “poor quality,” boosted by repurchases and low tax rates, writes Sacconaghi:

Even though IBM delivered 11% EPS growth in FY13, revenues declined, and the company saw a sharp decline in hardware profitability, which fell by $1.7B YoY (~$1.20 in EPS). While IBM was able to offset much of the decline through cost savings and margin expansion in software and services, IBM also excluded a $1B restructuring charge from non- GAAP EPS, a stark change from previous years when restructuring expenses (and any gains that offset charges) were included in the P&L. Moreover, a lower tax rate (which declined from 24.0% to 16.3%, due to various one-time items) generated over 85% of the company’s EPS growth ($1.48 out of $1.72). Additionally FCF was $15.0B, dramatically below net income of $18.7B [...] When IBM recently reaffirmed consensus estimates for 2014 and its target for 2015, investors appeared skeptical – in part because of the expected quality of its earnings. IBM’s announced sale of its server business to Lenovo (resulting in an expected $0.75 gain this year) less than 48 hours after earnings was a stark reminder to investors that IBM has so much financial flexibility to hit its EPS targets, that the metric is no longer relevant.

Investors are now focused on revenue growth, and it’s a concern, he writes,

With strong cost cutting and significant share buybacks (we expect the company to spend $15B on repurchases in FY14, and to front-load them), many investors expect IBM to hit its $20 EPS target, but remain concerned about the long-term health of the business. Revenue growth is likely to remain weak through FY14 (at constant currency, we forecast YoY growth of -0.9% in Q1; -3.2% in Q2; -0.2% in Q3 and +1.0% in Q4) and IBM’s guidance suggests that FCF will remain materially below non-GAAP net income (~$16B vs. net income of $18.4B) for the second consecutive year. We believe that IBM’s stock is unlikely to re-rate until the company can deliver improved revenue growth and is able to generate FCF that is relatively in line with non-GAAP net income.

It’s a bit of a mystery, writes Sacconaghi, why IBM is sticking to the EPS roadmap when it appears less and less relevant:

We expect IBM to repurchase $15B or more of its shares this year, and rebalance its workforce by at least 13,000 heads. Many investors believe IBM should be investing in its future by buying new technologies and investing in building capability, rather than rightsizing the organization. So why is IBM steadfastly driving to its roadmap? It is hard to say. Perhaps IBM genuinely believes it can invest and do what’s right for the business while simultaneously achieving its roadmap. Perhaps it is worried about disappointing Wall Street (though some believe the stock might go up if IBM reduced or eliminated its 2015 target in a constructive manner). Another possible explanation is that the roadmap/prevailing financial model is the way executives have always run the company, and changing it is uncomfortable and/or requires a different skill set and risk appetite. A final theory is that IBM’s financial incentives (senior executives’ incentive programs are based 60% on operating net income near-term and 80% of operating EPS long term) make the choice simple.

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FEBRUARY 3, 2014 7:50 P.M.

Paul Sutera wrote:

Many of us are the victims of IBM's 22 years of relentless downsizing. It makes sense that after awhile you begin to fire people who have talent, and the customers are tired of losing their favorite support person, the one they relied on for years. IBM has stuck to the EPS targets year after year while totally missing the boat on Cloud computing, even though they practically invented the term. They could have bought a reasonable Cloud solution instead of repackaging old software that was difficult to configure and monstrous in size. Now IBM stock has gone nowhere despite hitting EPS targets year after year. Ginny and the crowd of axe-wielding execs are focused on their own short-term compensation. So you tank the company, big deal when you've walked away with 150 million. The key is to hire someone who will only be compensated when they improve or at least stabilize revenue. And stop hiring people for 20 million a year, the person who will save the company loves technology and will work for 10 million.

FEBRUARY 3, 2014 9:14 P.M.

IBM global union alliance wrote:

There were times when IBMers were proud to work in one of the largest IT companies in the world. They were respected as employees, were well paid, had secure jobs and worked in an environment conducive to collaboration.

But things have changed in IBM since the company published its Road Maps for 2010 and 2015. Instead of focusing on the people that made IBM great, IBM is now transfixed by numbers and Earnings per Share (EPS).

In 2013, IBM spent $1 billion on what was called "workforce rebalancing", which means nothing else but a giant job cut. In 2014, the company is set to spend another $1 billion to eliminate an estimated 15,000 jobs worldwide. This comes at a time when the company still makes hefty profits.

UNI Global Union and the UNI IBM Global Union Alliance denounce the company's move to lay off its employees en masse. IBMers remain the company's biggest asset, and should be in the forefront of any change.. Alternatives to layoffs exist for companies to looking to cut costs. Retraining programs can yield positive results for both employees and the company, and have been implemented successfully in numerous companies.

Lee Conrad, from the Alliance@IBM CWA and UNI IBM Global Alliance coordinator said "The hits just keep coming. Following the news that job cuts will happen this quarter, the latest is that IBM will sell one of its server units to Chinese company Lenovo. 7500 workers worldwide will be impacted and moved out of IBM".

Said Alan Tate, head of UNI ICTS: "IBM needs to go back to its roots and focus on what made the company successful for over 100 years. It needs to invest in its employees and ensure decent work. Innovation is what made IBM a great company, not greed."

To follow the latest news and actions around the pending job cuts please visit the Alliance web site at http://www.allianceibm.org

It's becoming clearer by the minute that IBM needs a complete makeover, from its vision of what its mission in life is, to its growth strategy (not much point being in the constantly disruptive/disrupted tech industry of you don't have a growth story), to its approach to executing growth initiatives vs run-the-business activities. Toni Sacconaghi is quite right in point out that the focus on earnings has outlived itself and become an empty vessel for customers and investors alike. Whether or not Ms Rometty and her team are too focused on their own short-term compensation, as Paul Sutera points out, the company has to get out of the defensive, unimaginative box it is trapped in, if it is to have a real future and relevance in the market.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.